Morgan Stanley, the global investment bank, has cut its outlook on Indonesia’s equity market to neutral from positive on concerns that the rupiah’s volatility may hurt its evaluation.
“In our base case scenario, Indonesia’s market re-rating is constrained by potential volatility in currency,” Hozefa Topiwalla and Trong Tri Tran, analysts with Morgan Stanley Research for Asia Pacific, said in their report on equity markets in Southeast Asia released on Friday.
The analysts said that although a global growth slowdown would not affect Indonesia’s defensive domestic demand, the risk of foreign investors pulling out of Indonesia coupled with a tight current account could have a meaningful impact on the rupiah, thus hitting the equity market.
Morgan Stanley expects further volatility in the rupiah against the dollar after monthly data showed a trade deficit for the third consecutive month, widening to $1.3 billion in June from $490 million the previous month as weakening demand from Europe hit exports. In April, the deficit was $640 million.
The deficit also amounted to 1.8 percent of gross domestic product, up from 0.3 percent of GDP in May.
“In our view, the tolerance level for current-account deficits in Indonesia is lower because Indonesia’s capital account is more open compared to other emerging markets,” the report said. “As a result, its external funding linkages, as seen in its short-term external debt-to-foreign reserve ratio and foreign ownership of government bonds, are relatively higher. Potential balance of payments stress is likely to be the key source of Indonesia’s currency volatility.”
Morgan Stanley’s currency strategists expect the rupiah to weaken to 10,000 in the third quarter. It traded at 9,485 on Friday. Based on Bank Indonesia’s data, the rupiah has lost about 4.5 percent this year, while the benchmark Jakarta Composite Index has gained 7.3 percent.
This suggests that foreign investors who bought shares at the beginning of the year might see smaller gains as the rupiah loses value versus the dollar. Overseas investors accounted for about 40 percent of total trading on the Indonesia Stock Exchange this year, according to bourse data.
Should capital flight happen because of worsening global market conditions, Morgan Stanley expects its benchmark stock index the MSCI Indonesia to decline by as much as 38.3 percent from the current level.
In a bullish scenario, the MSCI Indonesia has an implied 37.5 percent upside. However, this scenario assumes a combination of improved global growth, double-digit investment growth and undershooting of headline inflation as Indonesia performs well driven by a market re-rating, earnings growth and strong foreign capital flows, Morgan Stanley said.
Still, Indonesia’s domestic consumption is expected to remain resilient and support the economy and equity market, the report said. Morgan Stanley is overweight on Indonesia’s financial sector and health care, and it recommends Bank Rakyat Indonesia, the second-biggest lender by assets, and Kalbe Farma, a pharmaceutical company.
In other regional markets, Morgan Stanley said that “Singapore remains our least-preferred market and we maintain our relatively sanguine view on Thailand.”
Potential earning downgrades combined with strong performance so far this year which resulted in a relatively more expensive market, supported its cautious view of the Singaporean market, according to the investment bank.
In Thailand, the analysts said that the nation’s economy was likely to be relatively immune to global growth shock as the government executed its “fiscal stimulus-led growth.”